Macroeconomics Assignment 1

1. What is the mechanism by which the "invisible hand" pushes markets to equilibrium?

Price is the mechanism by which the “invisible hand” pushes markets to equilibrium. Price directly affects the quantity demanded as well as the quantity supplied. The price has to be right in order for supply and demand to be balanced and reach equilibrium.

2. Explain the two main causes of market failure and give an example of each.

Market failure is a situation in which the market on its own fails to produce an efficient allocation of resources. One major cause of market failure is market power, which is the ability of a since economic actor (supplier) to have a substantial influence on market prices. This makes it hard or even impossible for other suppliers to enter the market, giving all control over price and supply to the single supplier. An example of this would be a monopoly. Microsoft was considered a monopoly up until 2001 when the government intervened. Before that, Microsoft had control of the computer market and prevented other sellers from entering the market, discouraging competition. Microsoft was able to set its own prices and in turn maximize profits at the expense of the buyer.

Another main cause of market failure is an externality, which is the impact of one person’s actions on the well-being of a bystander. An example of this would be a pharmaceutical company dumping toxic wastes into a nearby river. The company doesn’t pay for dumping the toxins; therefore the market price does not incorporate the actual opportunity cost of producing pharmaceuticals. The toxic waste ends up harming local bystanders, causing a larger social cost than a social benefit. Once again, this externality benefits the seller at the expense of the buyers and bystanders.

3. Use a production possibilities frontier to describe efficiency.

The graph above is a rough representation of a production possibilities frontier, which represents the efficiency of production as...